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Aon Hewitt Retirement and Investment Blog

The Shrinking Stock Universe and What It Means for Investors

Between 1996 and 2016, the number of publicly listed companies trading on US stock market exchanges has fallen by roughly 50 percent. Conversely, listings on the exchanges of developed countries outside of the US have risen by 50 percent, creating a listing gap of approximately 5,800 companies[1]. Data does not suggest that the number of companies that are eligible to list has decreased, but rather, points to the declining propensity for companies to do so. 
 
De-listings have been driven by a number of factors.  One of the primary reasons is cost. Regulatory compliance, following the enactment of the Dodd-Frank Wall Street Reform and Consumer Act, has become paramount within the industry and understandably so. However, compliance has the downside of more effort and cost.[2]
 
Merger & acquisition (M&A) activity has also been a culprit of company de-listings from the US exchanges. Recent market environments have been characterized by slower growth and low interest rates, which has made it easier to efficiently finance larger transactions.[3]
 
As a result of stock de-listings, we have observed some key changes in the investable universe and investor behavior:
 
1.     The composition of the US exchanges has evolved. For instance, the demographics of the companies listed on US exchanges are older and larger as the mean market capitalization and average age of listed companies (as of 2016) was $7 billion and 18 years, respectively. The mean market capitalization of companies in 2016 exceeded that of companies in 1976 by 10 times (in US dollars).The average age of companies in 1996 was 12 years.
2.     As a result of companies staying private longer, private equity and venture capital companies are also able to participate in the life cycle of companies much longer.
3.     A growing number of large mutual funds and hedge funds are participating in pre-IPO (Initial Public Offering) transactions to capitalize on potential alpha generation. For instance, in 2016, 26 mutual funds had $11.5 billion collectively invested in late stage venture companies. The majority of those funds were housed at large providers such as Fidelity, T. Rowe Price, and Wellington.[4] From a capitalization perspective, large cap managers have generally led participation in these pre-IPO transactions.[5]

Key Questions/Suggestions
 
The changing stock universe leads to some key questions as it relates to evaluating fund managers:
 
1.     Is there data suggesting that active managers’ performance is at risk as a result of the changing stock universe? If so, what managers are impacted the most?
There is no clear correlation between the shrinking universe of stocks and the relative performance of active managers. Furthermore, there is little data that concretely suggests that the shrinking stock universe adversely impacts one capitalization range more than another from a performance standpoint. Also, while the composition of the stock universe is larger and older, we suggest that it strengthens the efficiency that typically characterizes the large cap universe. As such, we continue to assert that an equity portfolio that is better positioned to generate alpha is one that allows for its manager to optimally employ stock selection skill.
 
2.      Does this change the way that managers should be evaluated?
As aforementioned, the changing stock universe has led some long-only equity managers to look outside of the public universe. This has challenged the dynamic for others that may not able to do that due to resourcing (e.g. subject matter experts, technology, etc.).  However, we do not believe that resourcing is indicative of research depth and talent. It is important to vet the research expertise at each manager and to ensure that the research is supported by strong governance. We also do not believe that participation in non-public opportunities alone subsequently leads to outperformance. Stock selection skill, and not just access, still matters.  As such, it is important to discuss specific research and portfolio construction guidelines, especially as it relates to investments in non-public companies.
 
Nicole Wubbena is a Senior Consultant in Aon Hewitt’s Global Investment Management group and is based in Chicago.



[1] Michael Mauboussin, Dan Callahan, Darius Majd. The Incredible Shrinking Universe of Stocks – The Causes and Consequences of Fewer US Equities.  March 22, 2017. http://dd.dgacm.org/editorialmanual/ed-guidelines/footnotes/footnotes_chap_05.htm
 
[2] Mauboussin, page 5
[3] Mauboussin, page 5
[4] Mauboussin, page 13
[5] https://www.cnbc.com/2017/05/17/mutual-funds-are-juicing-their-returns-by-investing-in-private-companies.html

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